The Fed vote was unanimous. The statement first looked like a dovish hike. The dot plot pointed to only one more rate hike this year and none in 2027, and odds of an October hike fell below 40%. Then Kevin Warsh spoke and the mood flipped. He gave no dot of his own, but revealed it by saying policymakers had "taken away a dose of accommodation." Futures then priced in more than a 53% chance of a hike on October 28, six days before the midterms. A hike that close to the midterms would be strange and unusually political for the Fed. What the data show between now and then will decide it.
Warsh's whole message was that the economy looks good, and that read is a bit naive. Yesterday's retail sales, once adjusted for inflation, show little going on - retail sales are actually falling. Sales are reported nominally, so the figures reflect higher prices paid, not units sold. United Airlines (UAL) and American Airlines (AAL) both said they will cut capacity because unit ticket sales are down. There are many crosscurrents. Warsh raised geopolitics, but war is not something monetary policy can fix. Rate hikes do not bring oil down; they only try to smooth out effects of high oil - food prices, transport, airlines.
Warsh sounded committed to price stability, arguing it helps people in the lowest income brackets most. In theory it does. Right now their credit card rates just went up. In the second quarter 57% of Americans who did cash-out refinancings accepted a higher mortgage rate. Those are variable-rate lines of credit that will carry higher costs, hitting the Americans who most need access to cash. Yesterday did not help small businesses or households.
The PCE quirks
The PCE has a quirk called portfolio management fees. Higher assets under management, driven by a rising stock market, do not reflect real demand or consumption. The Bureau of Economic Analysis will tamp that input down. There will also be downside from computers and peripherals, where prices are falling. On the other side, the consumer price index does not capture legal fees well, so those will feed through from the producer price index and add a little upside to the PCE. Bankruptcy attorney fees have gone through the roof, and bankruptcies are up year over year - small business bankruptcies up 64%. In these conditions someone always makes money, and right now it is bankruptcy lawyers.
Three payroll prints come between now and the December FOMC meeting, and the recent payroll data showed strange seasonal adjustments. Core PCE has moved from about 4.7% to about three and change - the right direction. Warsh wants a smaller share of prices rising by more than 3%. In the latest PCE that share dipped below 50%, down from what worried him at Jackson Hole.
Housing and household strain
Single-family permits went down again, which is unwelcome. More construction of smaller single-family homes would let smaller families buy in, instead of McMansions they do not need. Mortgage rates sit above 7%, around seven and a quarter. With credit card rates, auto loans, and rising delinquencies, the fix is a fatter financial cushion - hard to build if you cannot make ends meet while spending heavily at the gas pump and grocery store.
The AI trade warning
Investors should be careful. The Financial Times has shown how hyperscalers pump up their earnings: every time OpenAI or Anthropic gets a new funding round, that flows straight to the bottom line. Since buybacks ended, the MAG 7 have trickled down. The AI trade is very long in the tooth. Revenues and token costs are starting to show price declines, and it is that trade - plus defense and oil - holding up the market.
An analysis by Anna Wong at Bloomberg found that 100% of GDP growth, not 50%, comes from the AI trade. A fact-check confirmed AI is now more than 100% of US GDP growth. When you reach that level you have to start looking for turning points, and growth rates have already begun to come down.
The lesson is to diversify and hedge away from the peaking AI trade, while staying aware that stocks remain the place to be over the long term. There are other places to sit. Cash pays about 5% in a good money market fund just for sitting on the sidelines, better after yesterday. Manufacturing is paying more. Chevron (CVX) has not cut its dividend in decades.
Warsh's approach
Warsh keeps stressing trends. For an economist a trend is three months in a row. If core PCE keeps declining, he may call it a trend. He will keep investors on their toes by making them follow the data directly, rather than following how the Fed reacts to it.
